Rate cut closer as producer prices fall

Costs in the economy have dropped for the first time in more than two years, adding to the case for a rate cut when the Reserve Bank meets next week.

Australia’s producer price index fell by 0.3 per cent in the March quarter, taking the annual figure to 1.4 per cent, the Australian Bureau of Statistics said. Economists had tipped first-quarter PPI to rise 0.5 per cent and 2.2 per cent for the year.

The last time the PPI fell for a quarter was in the final three months of 2009 amid the turmoil of the global financial crisis.

Producer prices, while not having a direct link to consumer prices, give an indication of overall costs changes at work in the economy.

“Price pressures aren’t that great,” said National Australia Bank economist Alexandra Knight. “We’ve had a lot better conditions for agriculture so it’s taken some price pressure off there.

“We’ve seen a general softening in commodities prices in the first quarter too,” she said.

Markets bet on rate cut

The dollar slipped about a third of a US cent on the data as chances of a rate cut rise, and was recently trading at $US1.0338. Government bonds rose, pushing the yield on the 10-year security down by as much as seven basis points, or 0.07 percentage point, to 3.76 per cent, the lowest since February 3. Bond prices and yields move in opposite direction.

The Reserve Bank has already indicated it will consider cutting the 4.25 per cent cash rate at the May 1 policy meeting, providing inflation numbers are tame.

Financial markets imply a 92 per cent probability of a cut to 4 per cent in May, and almost 100 basis points of easing over the next 12 months.

Falling domestic prices

In the quarter, final stage domestic producer prices fell 0.1 per cent, compared to a 1.5 per cent drop in import prices, the ABS said.

The report showed the cost of agricultural products slumped 17.7 per cent, building construction dropped 0.2 per cent, and industrial machinery and equipment manufacturing declined 2.4 per cent. Prices for electricity, gas and water supply rose 2.1 per cent, it showed.

“The falling domestic prices were part of the story there," said Commonwealth Bank chief economist Michael Blythe. “I think people would have expected the imported component to come down given the strength of the Australian economy.

“It was a surprise,” he said.

Lower consumer price rise?

The PPI reading comes ahead of official consumer price index data to be released tomorrow which will give the clearest signal yet on whether the Reserve Bank will cut rates when it meets next week.

The weak PPI suggests the CPI could come in weaker than the 0.7 per cent quarterly increase expected by a consensus of analysts.

Economists said the weaker-than-expected producer prices, coupled with evidence of soft domestic prices added to the chance that tomorrow’s CPI data would be weaker than originally forecast.

“All up we’d characterise this as adding to downside risk to first-quarter CPI,” said ANZ senior economist Justin Fabo. The weak PPI may be linked to falling fruit and vegetable prices.

“[However] to the extent that it’s more broad-based it’s telling you something about momentum in the economy,” he said. “If it’s broad-based weakness in the domestic segment, that’s where the RBA would stand up and take more notice.”

In keeping official interest rates on hold in April, the RBA said that benign CPI data would give it scope to cut rates should it be necessary to support the domestic economy.